The government and market systems

Governments play an important role, even in market econo­mies, for two reasons:

1. Because of the inability of the market mechanism to deliver certain types of goods.

2. Because of weakness in the market system.

The first reason concerns what are known as public goods and services. Once they are provided, their benefits extend to all members of the community. The maintenance of law and order through the police force and the judiciary and national defence through the armed services are good examples.

If the supply of these goods was left to the market mechanism – the result would be an inadequate organisation of these services.

The other reason why governments may intervene is much more complex and raises many controversial issues. Since the market system operates through prices, the government may intervene to subsidise, or even provide free, essentials such as food, housing, medical care and education. Assisting people with low incomes is not the only motive for a government to reduce market prices in this way. It may also wish to actively encourage the consumption of what are known as merit goods (education, for example).

The opposite of merit goods are merit bads – commodities such as drugs and pornography. The consumption of these products should be discouraged by the government. Finally, a competitive market economy, if left unregulated, may be subject to slumps and booms because of the periodic lack of balance between total supply of goods and services and total demand. It may require some form of government action to help correct the situation. However, the extent of government action and its method of intervention are a matter of fierce dispute, not only among politicians and social reformers but also among economists. In his book, “The Wealth of Nations”, A. Smith argued strongly in favour of the competitive market mechanism, whose ‘invisible hand’ coordinated the activi­ties of producers and consumers.

Classical economists believed in maximum individual economic freedom and the minimum government regulation. Although they did acknowledge that where it is not possible to achieve efficiently operating markets then the government should intervene. The object of state intervention was to support and strengthen the market mechanism, not replace it completely.

The opposing view was presented by Karl Marx in a series of books published between 1848 and 1882.Marx stressed the conflicts and crises of the system. All capitalist institutions would finally be replaced by a one-party dictatorship of the proletariat, based on the state ownership of all means of production, distribution and exchange. These concepts inspired the 1917 Bolshevik Revolution and formed, until recently, the basis of Russian political thinking and action. However, Marx has been subjected to many different interpreta­tions. China, Yugoslavia and Cuba have all built systems very different from that of the former USSR - many of which are now being reformed.

On the whole, the functions of the government in economic life can be classified into the following categories:

-to preserve and foster competition

-to regulate monopolies

-to provide information and services to enable the market work better

-to provide certain goods and services

-to assure a sound monetary system

-to promote overall economic stability and growth